Monday, September 13, 2010

On the New Deal

I don’t know about you, but every time I hear the phrase “redistribution of wealth”, I get a shiver down my spine. Alas, as with any topic in economics, there are costs and benefits to consider. I suppose our obligation here on the policies of the “New Deal” is to weigh those costs against the benefits and see if we end up with a surplus or loss in social welfare. That’s a tall order.

The good that did come from the new deal took place in the financial sector, namely the creation of the Federal Deposit Insurance Corporation and the movement away from the gold standard. Restoring faith in the banking sector is a tough thing to do when banks are collapsing all around you. With the entire population withdrawing and holding any funds they could (in the form of gold), the government had no control at all over the money supply. The newly formed and well intentioned Federal Reserve was put to the test, which they failed miserably. The general population had no faith in the new economic system involving monetary policy; the very foundations of economics were far from understood. But the bank holiday imposed by FDR and the assurance that the banks that did re-open were backed by the federal government, that was the perfect move to make to restore faith. How else could he validate his claim “there is nothing to fear, but fear itself”? Creating the FDIC drove that point home. The confidence in the system that allows money to circulate was well worth the moral hazard it created. The foundation of the Security Exchange Committee fit perfectly into the correct government position, the enforcer of the rules. Even the Social Security Act was a positive move in its infancy; a forced retirement plan for all those suffering from money illusion and present value bias. But the biggest and boldest move was to remove the currency peg to the value of gold. Only then could the Federal Reserve really meet the conditions for which it was created. A free floating currency, free from the uncertainty of another market, is a prerequisite for controlled stability.

So was the New Deal a good one? I’m afraid not. That is why most of the policies were later removed. Did they work? Well, maybe. Unfortunately it is impossible to say. We can speculate, based on historical evidence that the markets would have corrected in the absence of any government “help”. What we can’t say is if the recovery would have taken longer or not. We also can’t tease out how much of the drawing out of the depression was due to fiscal policy and how much from monetary policy mistakes. The Federal Reserve was still relatively young and inexperienced. They didn’t really understand the impacts of changing the interest rates or the injection of new currency. One thing that is certain is that there was incongruence between the two policies which undoubtedly prolonged the depression beyond its natural life and without the social benefits of reduced unemployment or poverty.

1 comment:

  1. On the subject of the gold standard, here is a new paper by Doug Irwin on France's role in the Depression.

    From the abstract:
    "While the tightening of U.S. monetary policy in 1928 is often blamed for having initiated the downturn, France increased its share of world gold reserves from 7 percent to 27 percent between 1927 and 1932 and effectively sterilized most of this accumulation. This “gold hoarding” created an artificial shortage of reserves and put other countries under enormous deflationary pressure. Counterfactual simulations indicate that world prices would have increased slightly between 1929 and 1933, instead of declining calamitously, if the historical relationship between world gold reserves and world prices had continued."